The Fed Blog

Wednesday, May 29, 2013

I am impressed by soaring oil production in the US, which rose to a new cyclical high of 7.3mbd in mid-May. This output boosts industrial production. It also has been a windfall for the railroad industry where weekly car loadings of petroleum and chemical products has soared 41% over the past four years to a record high of 43,085 units in mid-May. That activity is helping to stoke the forward earnings of the S&P 500 Railroads into record territory.

Today's Morning Briefing: Great Rotations. (1) Breaking up is hard to do. (2) Rotating or reaching for yield? (3) April was good for dividend yielders. May was not. (4) Two scenarios for the summer: good vs. weak growth. (5) Are record new home prices auguring the end of negative home equity? (6) Railroads benefiting from oil boom. (7) Data support the Great Releveraging more than the Great Rotation. (8) Emerging market bonds are hot, stocks are not. (9) Focus on underweight-rated Telcom Services and Utilities. (10) The Federator. (More for subscribers.)

Tuesday, May 28, 2013

I predict that in the next 18-24 months, there will be no negative equity in America’s real estate market. Yesterday, we learned that the S&P/Case Shiller composite index of 20 metropolitan areas climbed 10.9% y/y during March, the biggest increase since April 2006, just before prices peaked in the summer of that year.

The 12-month moving average of the median existing single-family home price is up 10.5% since it bottomed during February 2012. It is still 18.9% below its record high during July 2006. Interestingly, the median price of a new single-family home recently rose to a new all-time high! No wonder that housing-related stocks continue to outperform the S&P 500. Consider the following:

(1) The 5/16 WSJreported that a group led by billionaire hedge-fund manager William Ackman is in contract to buy a penthouse apartment in Manhattan for more than $90 million. Citadel’s Ken Griffin has bought four adjoining properties in Palm Beach, Fla. for a total of nearly $130 million, adding to a $15 million buy he made in November of a penthouse apartment in Chicago that he is combining with the floor below.

(2) On Monday, the WSJreported that “[i]n California, the number of homes sold in recent months that had been flipped--or bought and resold within six months--has reached the highest levels since late 2005, according to PropertyRadar, a real-estate data firm. About 6,000 homes have been flipped in the state this year through April, or more than 5% of all homes sold statewide….Six of the 10 largest price gains in major U.S. cities over the past year have been in California, according to Zillow. In April, home values rose by 25% from a year earlier in San Jose, San Francisco and Sacramento, and by 18% in Los Angeles.”

(3) On Tuesday, the “Greater New York” section of the WSJ reported: “House prices in the New York City suburbs, after a six-year roller coaster ride in which they lost roughly a quarter of their value, are climbing again….Buyers who have been waiting have jumped back in, creating bidding wars for many desirable properties, brokers say. The number of new contracts signed is up; some homes are selling in a few days, often with multiple offers.”Today's Morning Briefing: Gilded Age. (1) Edging away from rational toward irrational exuberance. (2) From fairly valued to overvalued this summer? (3) New record highs for forward earnings. (4) As yields go up, P/Es go down according to Rule of 20. (5) The Fed’s MAMU dilemma. (6) End in sight for negative home equity. (7) Moody’s is less depressed about banks. (8) Consumers are happier. (9) Another Gilded Age already? (10) Gatsby’s bling. (More for subscribers.)

Monday, May 27, 2013

Also unsettling stock markets around the world last week was the big backup in government bond yields. In Japan, the 10-year yield has jumped from a record low of 0.45% on April 4, 2013 to 0.85% on Friday. It briefly touched 1.0% last Thursday. In the US, investors were spooked to see the 10-year yield back over 2% for the first time since March 15, 2013. It’s also back to the dividend yield of the S&P 500.

The rise in bond yields, particularly in Japan and the US, complicates life for all the central bankers who have been pushing the outer limits of QE. To keep us from going into the darkness, they have taken us to the brink of monetary policy's final frontier. The positive interpretation is that bond investors have concluded that the central bankers will succeed in stimulating self-sustaining economic growth and in boosting inflation rates. If so, then the monetary authorities do need to provide a credible exit plan from QE that won’t push yields back up to levels that depress economic activity. Alternatively, central bankers are in a Catch 22 situation in which rising yields depress economic growth, forcing the continuation of QE or even more of it!
What should they do?

What can they do? What will they do? When he was just a simple Fed governor, Ben Bernanke provided the answer in a remarkable speechon November 21, 2002 titled, “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” In it, he listed all the possible tools that central banks could use to avert deflation including ZIRP, QE, and even printing money. The major central banks have followed Bernanke’s advice except for actually running the printing presses, which is the ultimate final frontier of monetary policy.

However, other than printing money, there is still one tool mentioned by Bernanke that has not been used, i.e., pegging bond yields. Here is what he had to say on the subject: “A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt….”

Back then, he focused on doing so for the two-year note: “The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.”

Why not just go for it and peg the 10-year Treasury at 1.50% in the US and the 10-year JGB at 0.50%? This would be a variation on current QE programs that don’t specify any target levels for the yields of the bonds that are being purchased. That’s too bad since those yield pegs probably could have been achieved with much less buying of securities. Want proof of my assertion? Look at how ECB President Mario Draghi lowered yields in the peripheral euro zone bond markets simply by pledging to "do whatever it takes” to defend the euro. The ECB is the only major central bank that has fewer assets on its balance sheet than a year ago.

Tuesday, May 21, 2013

There does appear to be some irrational exuberance over in Europe. One of the greatest dichotomies in the global bull market in stocks is the stellar performance of European equity prices despite the ongoing recession in the euro zone. The MSCI Europe stock price index is up 81.2% since March 9, 2009 to a new cyclical high. The euro zone’s real GDP is down 1.5% over the past six quarters. It’s hard to imagine that investors are turning more optimistic on the future over there. For now, it still looks to be mostly a relief rally. Stocks have risen in Europe mostly on relief that the ECB has averted a Lehman-style financial meltdown, so far.

Monday’s FT included an article titled, “Wall of money eases Eurozone funding.” The print version of the same story yesterday was titled, "Eurozone makes hay while bond market shines.” It notes: “Encouraged by low market borrowing costs and strong investor demand, finance ministries are further ahead in funding programmes than at this stage in at least the past three years. France, Spain, Italy, Belgium and the Netherlands have raised more than half the year’s expected total, according to estimates by Barclays." That’s even though the region is in the worst recession since the monetary union started in 1999.

Investors are clearly reaching for yield all around the world, including in the peripheral countries of the euro zone. The FT reports: “When Spain last week issued 10-year bonds, demand was three times greater than the €7bn raised. Italy raised €6bn from 30-year bonds, the first with such a long maturity since 2009. Earlier this month, Portugal issued €3bn of new 10-year bonds, its first since the country requested an international bailout programme two years ago.”

Today's Morning Briefing: Group Hug. (1) One of the greatest relief rallies on record. (2) The Bullish Strategists Society. (3) Another 2-4 years for the bull? (4) Starting to believe in tomorrow again. (5) Irrational exuberance or rational relief in Europe? (6) Making hay in Europe’s bond market. (7) Not all profit margins have peaked. (More for subscribers.)

Monday, May 20, 2013

Now that there probably isn’t much more upside for profit margins, revenues will drive earnings. Revenues will be driven by the growth in global nominal GDP, which I expect will be 5% this year, next year, and maybe for each of the next four years. That’s probably the minimum that would be required to drive a secular bull market.

How are we doing? Not so good recently. S&P 500 revenues fell during Q1, and are up only 1.4% y/y. This series is highly correlated with the 12-month sum of the value of world exports, which has been flat for the past year.

A somewhat more encouraging indicator is 52-week forward consensus expected revenues for the S&P 500--the time-weighted average of analysts’ estimates for the current and the coming year. It remains on an uptrend, though it dipped during the Q1-2013 earnings season as analysts lowered their expectations for 2013 revenues because of all the negative revenue surprises.

Sunday, May 19, 2013

Fed Chairman Ben Bernanke seems to agree with my upbeat assessment of the future led by the ongoing high-tech revolution. He signed on to the thesis in a commencement speech on Saturday titled, “Economic Prospects for the Long Run.” That title is eerily similar to that of Jeremy Siegel’s investment textbook (1994), Stocks for the Long Run. His speech is also reminiscent of his predecessor’s cheerleading of the 1990s bull market. Bernanke said that he is optimistic about the long-term prospects for the US economy because he expects that “human innovation and creativity will continue.” He concluded that “historians of science have commented on our collective tendency to overestimate the short-term effects of new technologies while underestimating their longer-term potential.”

In the past, Bernanke explicitly stated that his ultra-easy monetary policy is aimed at driving stock prices higher. Now that they are at record highs, his recent cheerleading could contribute to a melt-up, just as Alan Greenspan did during the second half of the 1990s. We all know how that ended.

Greenspan, who was Fed Chairman from August 1987 to January 2006, was a big believer in the high-tech revolution during the second half of the 1990s. His last major speech about this subject was titled “Technology and the economy,” on January 13, 2000. Just as technology stocks were about to crash, he said: “When we look back at the 1990s, from the perspective of say 2010, the nature of the forces currently in train will have presumably become clearer. We may conceivably conclude from that vantage point that, at the turn of the millennium, the American economy was experiencing a once-in-a-century acceleration of innovation, which propelled forward productivity, output, corporate profits, and stock prices at a pace not seen in generations, if ever.”

Subsequently, Greenspan said that the financial crisis of 2008 was caused by a “once-in-a-century event,” i.e., the Lehman bankruptcy! Let’s hope that Bernanke won’t regret his latest speech.

The S&P 500 is now 6.5% above its previous record high on October 9, 2007. The current bull market seemed to be tracking the previous one (from 2003-2007), raising concerns that 2013 could play out as badly as did 2007. Now the two bull markets are diverging with the current one rising to new highs. It’s much easier now to make the case that the market may be just starting a melt-up, as I discussed last week.

Wednesday, May 15, 2013

"The end is near" has been the bears' dire prediction since the start of the bull market on March 9, 2009. This year's rally to new record highs suggests that the bears have lost their credibility and that investors are becoming increasingly convinced that the end is actually still far off.

For the past three years, the market's valuation multiple has been held down by fears that a financial meltdown in Europe, a double-dip recession in the US, and a hard landing in China will cause a recession. Yesterday, the forward P/E of the S&P 500 rose to 14.4. That's the highest since April 23, 2010, just before Greece hit the fan and just before the bears became obsessed with their Endgame scenario triggered by growth-crushing woes in Europe, the US, and China.

If the end of the Endgame is far off or if there is no end to the Endgame, then valuation multiples have been too low for the past three years and have room to move higher, which is what they are doing now. From this perspective, the recent valuation-led rally in stocks isn't irrational exuberance. Rather, it is a bullish rejection of the bearish and dreaded prediction of the Endgame prognosticators pontificating that the end is near or even imminent.

The mean of the monthly forward P/E of the S&P 500 since September 1978, when the data start, is 13.7. The recent valuation-led rally may simply be a reversion to the mean, as the P/E has rebounded from 12.1 at the end of last year on November 14 to 14.4 yesterday. The bull market’s trough P/E was actually 10.2 on October 3, 2011. The bull market’s peak P/E was 15.1 on October 14, 2009 before the bears distracted us with their Endgame scenario, which depressed P/Es. Reverting above the mean to 2009’s peak would put the S&P 500 at 1744, up 5.2% from yesterday’s close.

Today's Morning Briefing: MAMU? (1) If it looks like a melt-up, is it? (2) Sit back and relax? (3) It probably isn’t different this time. (4) Valuation multiple could revert back above its mean. (5) Rule of 20 puts P/E at 18. (6) The fundamentals are mixed. (7) But bad news is good news. (8) Going vertical. (9) Fasten your seat belt. (10) The Mother of All Melt-Ups? (11) Greenspan's melt-up. (More for subscribers.)

Tuesday, May 14, 2013

China may be slowing, but it’s still growing. I’m hard-pressed to see any signs of a hard landing in China anytime soon. Real GDP rose 7.7% y/y during Q1-2013, only a bit below the previous quarter’s 7.9% pace. Is that alarming? Not to me. I’m not alarmed by similar marginal declines in the growth rates of other recent economic indicators.

In the first four months of this year, China’s fixed-asset investment rose 20.6% y/y, marginally lower than the 20.9% gain in the first quarter. Still, investment in the property sector jumped 21.1% during the four months, up 0.9 percentage point from that in the first quarter. China’s industrial production rose 9.3% y/y in April, up from March’s 8.9%. Retail sales continue to post double-digit gains, rising 12.8% in April. Chinese oil demand rose to another record high in April.

Today's Morning Briefing: The End Is Far Off. (1) From near to far. (2) Nothing to fear but fear. (3) At 14.3, P/E is back to spring 2010 high. (4) If the end isn’t near, then P/Es have been too low. (5) Irrational exuberance or rational rejection of the Endgame? (6) The last correction was insignificant. (7) Averting the fiscal cliff was bullish. (8) Income shifting last year boosting federal revenues this year. (9) GDP passing the stall speed test. (10) Draghi passed a couple of tests earlier this year. (11) Hard-pressed to see hard landing in China’s numbers. (12) Focus on underweight-rated Energy sector. (More for subscribers.)

Monday, May 13, 2013

Let’s assess the impact of the latest company results on expectations for revenues and earnings for the remaining quarters of the year, as well as annual expectations for this year and next year:

On a weekly basis, I monitor the consensus expectations of industry analysts for quarterly and annual S&P 500 operating earnings. The consensus for Q1 at the start of the earnings season was $25.73 per share. The latest number as of the week of May 9, reflecting all the reported results, is exactly one dollar higher at $26.73. Over this same period, the estimates for Q2, Q3, and Q4 were knocked down $0.79, $0.55, $0.29, respectively, and $1.63 in total.

The 2013 and 2014 estimates fell to new lows of $110.98 and $123.39, with the former up 6.9% y/y and the latter up 11.2% y/y. While these y/y growth rates would be fine, I am troubled to see that forward earnings has been stuck around its record high of $115 for the past nine weeks. This is the measure of earnings that I believe drives the market.

Today's Morning Briefing: Yearning for Earnings. (1) Singing the blues about earnings. (2) Some are reaching for yield, while others are yearning for earnings. (3) Putting a high price on dividend growers. (4) Q1 results depressing estimates for the rest of the year. (5) Stay Home vs. Go Global. (6) Forward earnings stuck at record high in recent weeks. (7) Revenues growth estimates in the low single digits. (8) Analysts still expecting higher margins. (9) Focus on overweight-rated Retailers. (More for subscribers.)

Sunday, May 12, 2013

Central bankers claim that they aren’t starting a currency war. They deny that their policies are aimed at the competitive devaluation of their currencies. Let’s call it competitive ultra-easing. Consider the following:

(1) BOJ is going wild. On April 4, Japan’s central bank announced a plan to double the monetary base over two years from 138 trillion yen at the end of 2012 to 270 trillion yen at the end of 2014. (That would be $2.7 trillion at an exchange rate of 100 yen per dollar.) Reserve balances jumped 13.3 trillion yen during April. The yen has plunged from 79.39 on November 13, 2012 to 101.6 on Friday. The Nikkei is up 68.7% over this same period.

Last Thursday’s WSJ included an interesting articleabout China’s slowing economy, noting: “A sharp fall in factory prices--the 14th straight monthly decline--signals further trouble for a Chinese economy already facing mounting debt and slowing growth, as old-line industries struggle with growing overcapacity. Producer prices…dropped 2.4% in April, the sharpest decline since October, paced by particularly steep falls in the metals and chemicals sectors. That could add to concerns about China's slowdown in growth…because falling producer prices make it tougher for makers of industrial goods and commodities to make profits, pay off their debts and pay their suppliers on time.”

Last week, the People's Bank of China (PBOC) said that it will use various tools to guide “stable and reasonable” growth in money supply and credit. “The negative spillover effects from loose monetary policy in major economies are growing, which has helped pro-cyclical credit expansion at home,” the PBOC said.

Thursday, May 9, 2013

Wednesday, May 8, 2013

In the February 5 Morning Briefing, I outlined the Irrational Exuberance scenario as follows: “In a melt-up scenario, the market [S&P 500] would do just that, jumping to my yearend target [1665] or higher before the middle of the year. … The Fed’s critics, including dissenters on the FOMC, will warn that ultra-easy monetary policy is once again pumping air into a stock market bubble. So a melt-up could be followed by a meltdown, or at least a very nasty 15%-20% correction later this year if the Fed is forced to stop its quantitative easing by soaring stock prices…”

Alternatively, Fed Chairman Ben Bernanke and his dovish allies on the FOMC might respond to their critics by raising stock market margin requirements. During March, margin debt soared to $380 billion, up 28% y/y, matching the previous record high during July 2007. The margin requirement has been flat at 50% since January 1974.

Soaring margin debt certainly supports the charge that the Fed is once again inflating asset bubbles. However, valuation multiples aren’t flashing irrational exuberance yet, but that could change quickly in a debt-financed melt-up of stock prices.

Today's Morning Briefing: Exuberance. (1) Within shouting distance of 1665. (2) A short history of the bull’s P/E. (3) Taking Greece out of the P/E. (4) Probability-weighted math yields 1695 target for S&P 500. (5) Weighing the odds of a melt-up followed by a meltdown. (6) If stock prices soar, Fed will have to do something. (7) Phase out QE or raise margin requirements? (8) Throwing a wet towel on the bull. (9) Will someone please hit the pause button? (10) Good news out of Germany and China bolster outlook for slow, but steady global growth. (11) Copper starting to shine again? (More for subscribers.)

Tuesday, May 7, 2013

Dow Theoreticians insist that the stock market averages for the industrial and transportation companies should confirm one another. In a bull market, the Dow Jones Industrials Average (DJIA) and the Dow Jones Transportation Average (DJTA) should both be ascending. In a bear market, they should both be descending. The practitioners of this theory get very jittery if the two indexes diverge or if one of them lags significantly behind the other. So for example, if the DJIA is making new highs and the DJTA is not, or is going the other way, that makes them bearish on the overall market. That’s what happened in early April.

But now, all is well with the world again. The bulls are in charge again now that the DJIA and the DJTA are both happily charging together to new record highs. The S&P 500 Industrials Composite--which is the S&P 500 excluding Financials, Transports, and Utilities--and the S&P 500 Transportation Composite are also prancing along together to new record highs.

Monday, May 6, 2013

It is true that compensation of all employees has been trending down from a record high of 69% during Q2-1980 to 62% at the end of last year. Even worse is that wages and salaries in national income have dropped below 50% last year for the first time on record. Yet pre-tax personal income and disposable personal income were at 97% and 87% of national income at the end of last year. How can this be?

The answer is deficit-financed government spending on entitlements. National income shares are based on incomes before taxes and before the government redistributes income through entitlements, which have soared from around 5% of national income in the early 1960s to around 17% currently.

Of course, not all the money borrowed by the government comes from current national income produced and earned in the US. Some is borrowed from abroad. Some is monetized by the Fed through QE. It is a mounting burden on future generations.

The bears are right that this can’t be sustainable. One day they will be proven right about that.

Today's Morning Briefing: Crying Foul. (1) The bears were wrong about revenues. (2) Revenues, business sales, and GDP at record highs. (3) Latest earnings season had disappointing revenues. (4) Not so bad excluding falling Energy revenues. (5) Bears preach that Capitalists’ gain is Labor’s pain. (6) The market doesn’t take sides in class wars. (7) The government redistributes income, borrows from strangers, and prints money. (8) That’s all bullish until it isn’t. (9) Let It Be. (More for subscribers.)

Sunday, May 5, 2013

The forward P/E of the S&P 500 rose to 14.0 on Friday, the highest since April 2010. Over the past seven weeks, the forward earnings of the S&P 500 has leveled out around a record high of $115 per share. Now that the index is already within sight of my yearend Rational Exuberance target of 1665, what is the upside in an Irrational Exuberance melt-up scenario? Let’s review the potential upside suggested by some valuation models:

(1) Fed’s Stock Valuation Model. In 1997, I noticed that the second section of the Fed’s Monetary Policy Reportto Congress included a chart and a brief discussion of the close fit between the 10-year Treasury bond yield and the inverse of the S&P 500’s forward P/E. I dubbed it the "Fed’s Stock Valuation Model" (FSVM). The model became instantly popular and controversial, as discussed in a Wikipedia article about it.

Ironically, after I “discovered” the FSVM, the Fed never mentioned it again, and it hasn’t even worked for the past two decades. It was bullish on stocks during the bull markets of the previous and current decades. But they were driven mostly by rising earnings, while the secular trend in the valuation multiple was downwards. The FSVM currently suggests that stocks are 75% undervalued relative to bonds. Alternatively, bonds are grossly overvalued relative to stocks.

(2) Rules of 20. A simple alternative to the FSVM is the Rule of 20, which compares the forward P/E of the S&P 500 to the difference between 20 and the CPI inflation rate on a y/y basis. Currently, it shows that the P/E should be 18.5, well above the market’s current P/E of 14. That would put the S&P 500 at 2133, or 32% above Friday’s close.

A hybrid valuation multiple that combines the Rule of 20, the FSVM, and our Blue Angels multiplies the latest forward earnings of the S&P 500 by the P/E derived by subtracting the 10-year Treasury bond yield from 20. The result shows that the S&P 500 should be around 2100.

Today's Morning Briefing: Rules of 20. (1) The valuation question in London. (2) From downside to upside. (3) Ahead of schedule on yearend target. (4) Qualitative and quantitative dimensions of a melt-up scenario. (5) One more time: Don’t fight the central banks. (6) Phasing out phasing out QE. (7) Draghi “ready to act if needed.” (8) Japan may be a leading indicator. (9) Playing both defense and offense. (10) Valuation models for a melt-up scenario. (11) Payrolls rose, but paychecks fell in April. (12) Focus on market-weight-rated auto-related stocks. (More for subscribers.)

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ABOUT: Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research. This blog highlights excerpts from our research service, which is designed for investment and business professionals.

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